seven

Coca-Cola Versus Pepsi

The War Is Over

The intake of cola-flavoured sodas is falling off. In the United

States consumption of Coca-Cola has dropped to just under 100
litres per person per year. Which is still quite a lot. Sales of Pepsi-
Cola are not faring any better. Consumers in the developed world
are gradually giving up sodas, and the battle against overweight is
now a public-health priority. As a modest contribution to combat-
ing this scourge, I should point out that a 33 centilitre can of Coke
or Pepsi contains 38 grams of sugar, equivalent to nine teaspoons.
If you were to drink six litres a day, like Kathy O’Sullivan, a young
mother of two, your daily sugar intake would exceed half a kilo.1
So does the decline of soda consumption herald a truce between
the two cola giants? Why carry on fighting when your customers are
deserting you, not for a competitor but for healthier beverages?

Duel or Duopoly

But was there ever actually a war? It is surely high time to debunk
this misleading representation of competition as a zero-sum game,
or worse still a negative-sum game. When, as is the case here, it
involves two competitors, it is wrongly presented as a sort of boxing
match.
This sort of conception suggests that competition is only destruc-
tive. One of the two protagonists must disappear, eliminated by
a knock-out blow. The fist-fight inevitably ends with a winner and

57
Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 58 • Coca-Cola Versus Pepsi

a loser. It’s a zero-sum game. The martial metaphor is even more

misguided because war destroys much more wealth than it creates.
Competition can certainly be violent and companies aggressive, but
it is a positive-sum game. For an economist, competition is the key
incentive driving business to cut costs and innovate. As a result
consumers have the benefit of cheaper, better quality goods and
services. For business itself the gain may be far from negligible
because lower prices and innovation stimulate demand.
In other words, if we see competition as a combat sport, we’re only
getting a snapshot which wholly overlooks consumers. Sure enough
when the Coca-Cola Company lowers its prices, it wins customers
from its rival. It’s the same when PepsiCo hires Michael Jackson for
an advertising campaign. For the firms it is indeed a zero or negative-
sum game when the competition adopts the same strategy of lower
prices or publicity spending. But this is only true if we take a static
view.
You may think it’s going a bit far to suggest a positive, dynamic
vision of competition with regard to cola-flavoured sodas, given that
competition boosts demand for a product not necessarily too good
for health. Economic theory would say that if the behaviour of
consumers is prejudicial to third-parties or society – for example
because obesity is hard on the public purse – it is up to government to
take the appropriate measures. Which is beginning to happen.
The governments of Indiana, Chicago, Mexico, France and even
the island of Saint Helena, among others, have introduced tax on
sodas. If the competition heats up in polluting industries or the
market for cocaine, the solution is not to rein it in order to reduce
production but to act on prices through taxation or make it an
offence.
Rivalry between Coca-Cola and PepsiCo is not a form of warfare:
it is a competitive oligopoly. We might even say it’s a duopoly
because the two firms control almost the entire market for soda-
flavoured colas. But with demand falling in developed countries,

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 Competition Between Substitutable Goods • 59

competition is slackening and its focus shifting. Let’s take a more

detailed look at all this.

Competition Between Substitutable Goods

Duopolistic competition in the cola market does not impact so
much on price as on other dimensions. Yet there is surely nothing
more like a can of Coke than a can of Pepsi? However, in a duopoly
based on perfectly substitutable goods, competition impacts solely
on price and annihilates any hope of profit for either firm. Just over
a century ago, the French mathematician Joseph Bertrand demon-
strated that in such a case a duopoly’s equilibrium price is equal to
the marginal cost, the same price as in a situation of perfect compe-
tition with a very large number of producers! If one of the two firms
sets a price slightly lower than its competitor, all the consumers in
the market will buy the former’s product; the second firm must in
turn set an even lower price to corner the market. This process of
successive price cuts will end when the price can go no lower, in
other words when it equals the unit cost. Below that limit the
company would lose money. Obviously the lack of any constraint
on the production capacity of the two players is a key assumption in
this model. And of course it does not hold true for Coca-Cola and
Pepsi. Gigantic as it is, their individual capacity for manufacturing
cola concentrate and bottling soda does not match total demand.
But in any case, cut-throat competition of this sort does not
apply to our duopoly because their products are not perfectly sub-
stitutable, due to the corresponding brands. The findings of labora-
tory tests are categorical. Subjected to blind tests consumers are
unable to say whether the beverage they have tasted is Coke or
Pepsi. The proportion of right answers does not significantly differ
from the results of random choice. The results are the same when the
glasses presented and tasted one after another contain different
colas, or contain the same beverage, but without test participants

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 60 • Coca-Cola Versus Pepsi

being told they are drinking the same thing each time. Regarding
their preferences, it seems that Pepsi came out on top in the blind
tests. But this result is disputed, as it is based mainly on tests
organized by Pepsi in supermarkets. Critics claim that its cola was
served slightly cooler than the rival beverage, which biased the
outcome. An alternative explanation, slightly less machiavellian,
is that Pepsi has a slightly higher sugar content. Both the palate and
the brain of homo sapiens like the taste of sugar.
Either way, consumer preferences change with any mention of
brands. Witness real-life experience: shoppers buy more Coke than
Pepsi in supermarkets, where the two brands appear side by side.
Magnetic-resonance imagery confirms this advantage. An experi-
ment reported in a neuroscience journal showed that the same
part of the brain was activated when a participant in a blind test
drank Coke or Pepsi.2 In contrast, when they knew it was Coke
another part of the brain lit up too, revealing a particular emotion.
So clearly brand awareness leaves its mark on our minds! Their
preference for Coke is probably due to advertising. The Atlanta-
based firm spends more than $2 billion a year on publicity, far
outstripping Pepsi. It has been doing so for decades.

Price, Switching Costs and Other Tools

With regard to competition, the presence of brands creates friction

in demand, which economists refer to as switching costs. Such
friction is equal to the sum that must be given to a consumer for
them to accept a change of product or supplier. According to
recent research, consumers of Coke would switch to the competi-
tor’s cola on condition they were given 30 cents a can, which would
be equivalent to selling Pepsi with a 30% discount on its current
price.3 Just 13 cents would convince adepts of Pepsi to switch
brands. However one cannot generalize on the basis of these
figures. The relevant research was based exclusively on purchasing

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 Price, Switching Costs and Other Tools • 61

behaviour in a supermarket of a large US city in the early 1990s.

It does nevertheless illustrate that Coke drinkers display greater
loyalty to their preferred brand than their Pepsi fellows. This no
doubt explains why Coke is on sale almost everywhere and always
more expensive than Pepsi.
So Coca-Cola and Pepsi do not compete on price, apart from
promotional drives linked in particular to moving into a new area or
launching new packaging. Moreover, there have been few periods
of price war. Competition is nevertheless very real: it just takes other
forms. Let’s look at three examples.
First, competition in publicity to create and maintain brand loy-
alty, and consequently recruit stars too. Sticking with the duel
theme, Olympic boxer Marlen Esparza punches for Coke, whereas
amateur wrestler Henry Cejudo fights for Pepsi.
Second, competition for control of upstream activities in order
to contain costs and prices. For a long time, an independent
network was tasked with processing concentrate, bottling – now
mainly canning – and distribution. Thanks to a series of acquisi-
tions, Coca-Cola and PepsiCo have gradually taken over these
companies. In the USA, this was a massive undertaking, leaving
independent bottling plants with less than 15% market share.4
Third, competition for the exclusive presence of their goods
to capture more customers, and to trigger and secure loyalty. On
supermarket shelves the duopoly’s products are stacked side by
side, often competing with other brands, such as Sam’s Cola at
Walmart or Cola Classic at Carrefour. In contrast, consumers have
no choice at filling stations, cafeterias, snack bars or even baker’s
shops. In this sort of outlet, space is too limited to install several
refrigerated cabinets stocked with bottles and cans. There is keen
rivalry between Coca-Cola and PepsiCo to reach exclusive agree-
ments with such retailers, for it is a way of generating repeat sales.
Part of the customer base of such outlets are regulars. The chances
are that when they go elsewhere they will purchase the cola that

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 62 • Coca-Cola Versus Pepsi

has, by force of habit, become their preferred choice. Competition

between the brands is even stiffer to obtain exclusive contracts
with leading chains and keep the soda fountain flowing.
McDonald’s is Coca-Cola’s top blue-chip customer. The Atlanta-
based brand also has an exclusive contract with Burger King. If you
prefer Tex-Mex food, chicken rather burgers, you’ll be drinking
Pepsi at Taco Bell or KFC.

Innovation and Its Limits

Lastly, competition is a key driving force for innovation. The world

of Coca Light, Pepsi Light, Coca-Cola Zero, Pepsi Max, Coke Life
and Next Pepsi has not always existed. PepsiCo started the ball
rolling with artificial sweeteners replacing saccharine. That was in
1964. Veteran consumers will no doubt recall the stunning flop of
New Coke. This new recipe with a slightly sweeter taste was rolled
out in 1985 to coincide with the brand’s hundredth anniversary.
The plan was for it to completely replace the previous version, blind
tests having shown that a majority of participants preferred it to
Pepsi Cola and conventional Coke.
The switch was announced on 23 April, with production of the
traditional recipe stopping a week later. But as there is a chasm
between what people prefer during blind tests and in real life, many
consumers started hoarding the old stuff and thousands of others
indignantly complained to the firm by phone or in writing. Word
has it that even Fidel Castro, a great Coke drinker, joined the
uprising. He purportedly saw the change as yet another sign of the
decadence of capitalism.
Coca-Cola reacted by relaunching the traditional beverage three
months later. Classic and New Coke co-existed for a few years, then
the newcomer vanished into the dustbin of history and Classic
became good old Coke again. The year of the Coca-Cola centenary
was one of the rare occasions when Pepsi sales exceed those of Coke.

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008
 Less Intense Competition • 63

Less Intense Competition

In the world of today, with the steady slide in demand for sodas,
competition is less intense. Indeed, we are seeing the opposite of
a price war. If Coca-Cola ups its price, Pepsi follows suit, and vice-
versa. But there is nothing co-ordinated about this process, no collu-
sion akin to what we have seen in cartels or alliances (see Chapter 5).
With falling demand becoming a durable trend there is less pressure to
make dynamic price trade-offs. The choice between reaping the
benefits of brand loyalty today by selling at a higher price to loyal
customers, or broadening the future customer base by setting a lower
price to poach the competition’s consumers has shifted.
The focus of competition has also moved as demand has
declined. Coca-Cola and PepsiCo do not only market cola-
flavoured water containing varying amounts of sugar, they also
sell mineral water, fruit juice, smoothies and such. PepsiCo has
taken the lead here, doing much more to diversify into other
beverages. It is investing more in health-conscious drinks than
the Atlanta firm and has done for longer. But the war – which is
not a war – is still being waged on the original battlefield – which is
not a battlefield either – for there is still much to be done to slake
the thirst for cola among the middle classes of India, China and
other Asian countries.

Notes
1. Daily Mail, 24 January 2016, www.dailymail.co.uk/femail/article-3414263/
Mum-addicted-Coke-drinks-SIX-LITRES.html.
2. McClure, S. et al. (2004), ‘Neural correlates of behavioral preference for
culturally familiar drinks’, Neuron, 44: 379–387.
3. Chan, T., Cosguner, K. and Seetharaman, S. (2012), ‘Structural econo-
metric model of dynamic manufacturer pricing: a case study of the cola
market’, Social Science Research Network.
4. Slind, M. and Yoffie, D. (2006), ‘Cola wars continue: Coke and Pepsi in
2006’, Harvard Business School Case 706–447.

Downloaded from https://www.cambridge.org/core. IP address: 59.90.60.58, on 01 Apr 2020 at 05:54:29, subject to the Cambridge Core terms
of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/9781108562546.008